Operation Twist

If somebody took money out of one pocket and then put it back into another, it would be hard to think that there had been any significant change. That is what the US Federal Reserve has just done, and it is meant to be a major policy initiative! I would not normally want to discuss in this forum the details of yields available on US government securities, but the latest policy move from the US Fed demands that these be given some attention.

Today, the Fed announced a new anti-crisis policy that has been dubbed ‘Operation Twist’, and the more closely one examines what is going on the worse is the conclusion one must draw about the prospects for US (and global) capitalism. Faced with official interest rates that are already zero, and having a balance sheet that holds nearly a trillion dollars of toxic bank securities from previous rounds of its ‘quantitative easing’, the Fed has basically run out of room to implement further expansionary monetary policies. This is no small problem, since the previous policies have had no lasting effect on the economy. So, its latest trick is to alter the mix of assets it holds, leaving the total size of its balance sheet unchanged. The basic idea is to sell one portion of its US government securities and to use the funds to buy some more.

One may sensibly ask: ‘What possible good can this do?’ The official rationale is that the Fed thinks that short-term yields are already low enough – since it has promised to keep interest rates at zero until mid-2013 – but that long-term yields are still too high. It believes that the high long-term yields are a constraint on investment and on spending in the economy. By selling $400bn of government securities on its books that have maturities up to three years, it can buy $400bn in the market with maturities from six up to 30 years. One-third of the $400bn is to be spent on US Treasuries with 20-30 years to maturity. The effect will be to push shorter-term yields up and longer-term yields down.

Following the Fed announcement, two-year yields did rise from 0.l6% to 0.20%, and yields beyond six years fell. But the problem comes to light when one looks at the level of yields that is supposed to be holding US capitalism back. The 10-year US Treasury yields fell to 1.86% today, the lowest for more than 60 years. But before this drop the yield was only 1.94%. The 30-year yield fell from 3.20% to 3.00%. These yields are lower than CPI inflation, currently running at 3.8% year-on-year.

The low level of yields reflects stagnant investment and a crisis of capital accumulation. The Fed trying to make long-term interest rates even lower will do little to change this, and its own lack of confidence is revealed in its assessment that “there are significant downside risks to the economic outlook, including strains in global financial markets”.

Another dimension of the Fed’s new policy was that it would use any early repayments from its holdings of mortgage securities to reinvest back into debt issued by mortgage agencies such as Fannie Mae. So, rather than looking forward to getting rid of toxic assets, it is committing to keep the same volume of junk on its books!

The Fed’s policies are not exceptional. Similar stunts are under way from the Bank of England, the European Central Bank and others as they grapple with the intractable crisis. However, the latest trick must rank high in the annals of moribund capitalism!